Forte Oil Plc: Will Planned Divestment Unlock Value?

Having
received approval from its shareholders in May 2018 to dissolve its
subsidiaries, FO released its first financials detailing the performance of
both the continuing and the discontinued operations1. As at H1 18, revenue from
discontinued operations printed at N21 billion (vs N18 billion in H1 17), with
net earnings of N7.8 billion, accounting for 99% of the company’s profit. Using
comparable company analysis, the minimum expected proceed for the discontinued
operations stands at N49.7 billion which is still a premium to its current net
asset value (NAV) of N35 billion.

For
clarity, as at H1 18, the assets sum up to N94 billion, with liabilities of N34
billion, translating to a net asset value of N60 billion. Overlaying FO’s
stake2 in the subsidiaries to the total NAV of N60 billion, translates to an
asset value of N35 billion. Overall, given the expected proceeds from this
sale, we think the company is likely to create more value for investors, given
management’s guidance of using the proceeds for expansion of its downstream
operations. To add, the proposed divestment will steer special dividend payment
in 2019, in our view.

Estimating the worth of the continued business

Focusing
on FO’s continuing operations, we adjust our model to mirror the new business
model (Nigerian downstream operations and solar systems). To recall,
major pressure points for the company in 2017 was higher input and finance cost
– related to power loans. However, given the new business structure, we foresee
a significant drop in its finance charge, following the reduction in its
borrowing and the extinction of the power business. For context, the company’s
borrowings dropped from N20.7 billion as at FY 17 to N7.2 billion to H1 18.

On
our 2018 numbers, we forecast a revenue estimate N107 billion (+18% YoY) driven
by increased receipts from petroleum products and lubricants. On petroleum
products, we expect FY 18 volumes to print at 507 million litres (+22% YoY)
which overlaid on our expected average petroleum products3 price forecast of
N186.25/litre, should settle FY 18 revenue at N94.6 billion. For context,
petroleum products sold over H1 18, by our estimate, stands at 300 million
litres (H1 17: 218 million litres) – a fallout of significant supply by the NNPC
in a bid to combat fuel scarcity. However, over H2 18, we see a moderation in
supply as NNPC normalizes its importation of PMS. In addition, we expect a soft
growth in lubricants’ sales (+5% YoY to N12.7 billion).

For
us, we perceive the input cost pressures would likely persist over the rest of
the year, given the uptrend in the landing cost of petroleum products in line
with rising crude oil price. That said, we model a 91% cost to sales (FY 17:
88%) ratio, which translates to N97 billion for FY 18. Accordingly, gross
profit would drop to N9.8 billion with respective margin at 9.2%.

Elsewhere,
given that the turbine related depreciation expense would no longer reflect in
its financials, the company’s operating expense is expected to print at N8.3
billion. Overlaying the numbers with other income of N1.7 billion translates to
an operating income of N3.2 billion. Another positive is a reduction in finance
cost, given that the company paid down a significant portion of its long-term
debt as at H1 18 to N7.2 billion (Dec 17: N20.7 billion). We therefore forecast
a net finance cost of N2.0 billion (FY 17: N3.6 billion) which should settle
PBT for the year at N1.2 billion and PAT at N839 million.

Beyond
2018, we model a gradual growth in sales with our 4-year CAGR of 5.1% hinged on
the possibility of upward adjustment in domestic PMS price, while cost is
expected to rise at a slower pace with 4-year CAGR of 3.1%. Accordingly, we
forecast gross margin to average 13.1% over our forecast horizon (vs 5-year
historical average of 10.2%). Elsewhere, we also perceive a moderation in
finance cost as our estimate of proceeds of sale from the discontinued
operations should reduce its borrowing burden in the near term. Also, the
company has given no indications of raising funds in the debt market in the
near term. That said, we expect earnings CAGR of 56.4% to N4.7 billion in 2022.

Therefore,
on our revised numbers, we now have a blended FVE of N34.35 (vs N61.44 in
previous communication) using a blend of DCF and Residual Income with
respective weights at 50% each. Relative to last closing price, this translates
to 58.3% premium and a BUY rating on the shares. The company currently trades
at a forward P/E of 5.37x which is at a discount to peer average of 7.54x.